05-36 SEC Approves New Interpretive Material to Rule 10308 Regarding Arbitrators Who Also Serve as Mediators

The Securities and Exchange Commission (SEC) has approved a new
Interpretive Material (IM) to Rule 10308 of the NASD Code of
Arbitration Procedure (Code) relating to mediators who also serve
as arbitrators.1 The amendments clarify that (1) fees for service as a
mediator are not included in determining whether an attorney,
accountant, or other professional derives 10 percent of his or her
annual revenue from industry-related parties; and (2) service as a
mediator is not included in determining whether an attorney,
accountant, or other professional devotes 20 percent or more of
his or her professional work to securities industry clients. IM-10308
can be found in this Notice as Attachment A.

The effective date of this rule change is May 6, 2005, for arbitrator
applications received or arbitrator disclosures reviewed on or after
that date.

Questions/Further Information

Questions regarding this Notice may be directed to Jean I. Feeney,
Vice President and Chief Counsel, Dispute Resolution, at (202)
728-6959 or jean.feeney@nasd.com; or Barbara L. Brady, Associate
Vice President and Director of Neutral Management, Dispute
Resolution, at (212) 858-4352 or barbara.brady@nasd.com.

Background and Discussion

Rule 10308 of the Code classifies arbitrators as "public" or "non-public." When
investors have a dispute with broker-dealer firms or associated persons in NASD
arbitration, they are entitled to have their cases heard by a single public arbitrator or a
majority-public panel consisting of two public arbitrators and one non-public arbitrator,
depending on the amount of the claim.2 Several rule changes relating to arbitrator
classification were approved by the SEC and implemented by NASD on July 19, 2004.3
These changes amended the definitions of public and non-public arbitrators.

In the course of implementing the 2004 arbitrator classification amendments, NASD
surveyed its entire roster of arbitrators, asking questions that tracked the new
definitions. In light of information contained in their responses, some arbitrators were
reclassified from public to non-public or from non-public to public, and some
arbitrators were dropped from the roster for various reasons.

One new part of the rule provided that arbitrators who were otherwise qualified as
public could not continue to serve as public if their firms derived more than 10 percent
of their revenue from industry parties. Specifically, Rule 10308(a)(5)(A) was amended to
read as follows:

The term "public arbitrator" means a person who is otherwise qualified to serve
as an arbitrator and…(iv) is not an attorney, accountant, or other professional
whose firm derived 10 percent or more of its annual revenue in the past 2 years
from any persons or entities listed in paragraph (a)(4)(A)….

Some arbitrators who also serve as mediators raised a concern about the application of
the above rule to their practice, because both sides in mediation normally pay a share
of the mediator's fees. They noted that the above rule change could be construed
broadly enough to encompass income in the form of mediation fees paid by industry
parties, meaning that these mediators would no longer qualify as public arbitrators
under the new rule. A similar situation could arise with regard to Rule 10308(a)(4)(C) ,
which classifies an arbitrator as non-public if the person devoted 20 percent or more
of his or her professional work in the past two years to securities industry clients. This
was not the intent of the recent rule changes. Mediators are expected to be neutral
and do not represent either side in a mediation.

Therefore, NASD is issuing a clarification in IM-10308 to make clear that, so long as the
mediator is acting in the capacity of a mediator and is not representing a party in the
mediation: (1) fees for service as a mediator are not included in determining whether
an attorney, accountant, or other professional derives 10 percent of his or her annual
revenue from industry-related parties under Rule 10308(a)(5)(A)(iv); and (2) service as a
mediator is not included in determining whether an attorney, accountant, or other
professional devotes 20 percent or more of his or her professional work to securities
industry clients, for purposes of Rule 10308(a)(4)(C).

In considering this matter, NASD recognizes that parties may wish to know that an
arbitrator on their list also serves as a mediator and may be familiar with the industry
parties or their counsel. NASD will prepare materials to inform arbitrators of the need
to disclose this fact on their disclosure forms, and will provide this information to
parties on whose case the arbitrators may serve.

Effective Date Provisions

The new Interpretive Material will become effective on May 6, 2005. The amendments
will apply to arbitrator applications received or arbitrator disclosures reviewed on or
after that date. Because this Interpretive Material clarifies NASD's original intent in
changing arbitrator classifications in July 2004, it will apply to all arbitrators on the
NASD roster, as well as to new and pending applications. NASD Dispute Resolution
staff will contact those arbitrators who were removed from the roster because of
misunderstandings over the effect of mediator fees on Rule 10308(a)(4)(C) and
(a)(5)(A)(iv). Other arbitrators who believe they are affected by this change may
request reinstatement to the roster.

2SeeRule 10308(b). Rules governing intraindustry
arbitrations use the same definitions
of public and non-public, although the panel
composition may vary depending on the nature
of the dispute, as well as the amount in dispute.
See Rule 10202.

Mediation services performed by mediators who are also arbitrators shall not be included in the definition
of "professional work" for purposes of Rule 10308(a)(4)(C), so long as the mediator is acting in the capacity of a
mediator and is not representing a party in the mediation.

Mediation fees received by mediators who are also arbitrators shall not be included in the definition of
"revenue" for purposes of Rule 10308(a)(5)(A)(iv), so long as the mediator is acting in the capacity of a mediator
and is not representing a party in the mediation.

Arbitrators who also serve as mediators shall disclose that fact on their arbitrator disclosure forms.